Memeorandum

March 30, 2009

We Get Pensive On Pensions

Inspired by a Boston Globe story and aroused by the indignant yet underinformed Josh Marshall, lefties are aghast that the Pension Benefit Guaranty Corporation switched "much of" (per the Globe) or "most" (per the unflappable Josh Marshall) of its portfolio from safe bonds to risky stocks last February, prior to the stock market wipe-out (see "FEEL THE RAGE", below). However, our friends on the left are so intent on bashing Bush and his appointees that they have overlooked some good news, which I will bury for a while. In fact, assistant treasury secretary nominee Alan Krueger will make an appearance on my side of the debate. But if you can't bear the suspense - yes, the left has gone fact-free on this.

Here is the Globe:

WASHINGTON - Just months before the start of last year's stock market
collapse, the federal agency that insures the retirement funds of 44
million Americans departed from its conservative investment strategy
and decided to put much of its $64 billion insurance fund into stocks.

Switching from a heavy reliance on bonds, the Pension Benefit Guaranty Corporation decided to pour billions of dollars into speculative investments such
as stocks in emerging foreign markets, real estate, and private equity
funds.

The agency refused to say how much of the new investment
strategy has been implemented or how the fund has fared during the
downturn. The agency would only say that its fund was down 6.5 percent
- and all of its stock-related investments were down 23 percent - as of
last Sept. 30, the end of its fiscal year. But that was before most of
the recent stock market decline and just before the investment switch
was scheduled to begin in earnest.

Careful readers will note that the Globe makes a distinction between "decision" and "action". Then there is Dr. M:

The more I look at these investment decisions
of Pension Benefit Guaranty Corporation and former Lehman exec Charles
Millard the more my suspicion grows that some very bad happened here.
There's no question that something happened very bad for the pensioners
who were relying on this fund. But is there any conceivable good reason
why you'd take most (the quote from the Boston Globe is
"much" of the funds) of the assets of the fund designed to insure
pension benefits out of safe investments like bonds and put them into
highly speculative investments -- hedge fund, equities, etc. -- just
before the stock market collapsed.

Incompetence doesn't cut it as an explanation.

So many questions, so many answers. First, anyone with the patience to make it to the end of the original Boston Globe article will learn that "much of" and "most" are actually targets of roughly 45% stocks and 10% real estate and esoteric stuff. That is up from a current target of 15-25% equities. Or one can findcoverage of the announcement last year and get the same answer. The Globe:

Under Millard's strategy, the pension agency was directed to invest 55
percent of its funds in stocks and real estate. That included 20
percent in US stocks, 19 percent in foreign stocks, 6 percent in what
the agency's records term "emerging market" stocks, 5 percent in
private real estate and 5 percent in private equity firms.

As to why some fool would do this, well, I'll agree that there is a huge covariance problem since the PBGC's equity portfolio will be tend to be down during times of economic weakness when distressed firms are more likely to fail and drop their pension plan into PBGC's lap. However, the evident intention was to spare Congress some embarrassment:

[Charles E.F. Millard, the former agency director who implemented the strategy until the Bush administration departed on Jan. 20] said the previous strategy of relying mostly on
bonds would never garner enough money to eliminate the agency's
deficit. "The prior policy virtually guaranteed that some day a
multibillion-dollar bailout would be required from Congress," Millard
said.

He said he believed the new policy - which includes
such potentially higher-growth investments as foreign stocks and
private real estate - would lessen, but not eliminate, the possibility
that a bailout is needed.

Well - heads the government wins, tails they are already losing so what is a few billion more among Congressman?

But I promised some good news! With a burst of creativity and insight I actually went to the PBGC website and checked their most recent annual report, for their fiscal year ending Sept 30. The gist? Talk is cheap and the expensive actions have not been taken - all the PBGC seems to have done so far is to lay the groundwork for the investment shift; as of Sept 30, 2008 their actual allocation had not changed notably. Here we go, in their discussion of the new investment strategy (p. 17 of 88):

PBGC has taken a careful and deliberate approach to the implementation of this new policy [described above as an increased commitment to equities]. At the end of FY 2008, the Corporation had selected investment managers for its fixed income and equity allocations, and had initiated an exhaustive search for strategic partners to assist in managing PBGC’s investments in both private equity and real estate.

In FY 2008, PBGC continued to hold a large portion of its investments in long duration fixed income securities, while working to transition the assets into the new target allocations. PBGC will continue to take a prudent and careful approach to the phased implementation of this long-term policy in FY 2009 and beyond.

Wow, it's almost as if they are taking their time. And they are:

Cash and fixed income securities totaled approximately 71 percent of total assets invested at the end of FY 2008, compared to 68 percent for FY 2007. Equity securities represented 27 percent of total assets invested at the end of FY 2008, compared to 32 percent for FY 2007. The total return on investments for FY 2008 was -6.5% compared to 7.2% in 2007. Alternative investments, comprised largely of private equity acquired from trusteed plans, represented 2% of investments atthe end of FY 2008.

Now, by the time this report was prepared in November the PBGC knew that soft-pedaling its switch to equities was prudent. However, the advertised switch had not taken place as of Sept 30 - alternative investments was stuck at 2% and equities were down from 32% to 27% of the portfolio (partly due to market declines, no doubt).

This report is as of Sept 30, 2008, which follows the Lehman/AIG debacle but precedes the full October meltdown. As of Sept 30 the S&P 500 was at 1164, compared to its current level of about 800 and an Oct 31 2008 level of 968.

PBGC has developed a plan for gradual implementation of the new policy
to prevent any disruptions in financial markets. The Board
Representatives have been deeply involved in crafting the new
investment policy and will continue to oversee its implementation.

Well, if they hadn't made any notable moves as of Sept 30 and expected future moves to be "gradual", maybe the current panic among the punditocracy is premature.

Now, it is possible that the newly-hired money managers ignored that "gradual" admonition and chose early October as the time to plunge with both feet into the most turbulent market in recent history of this millennium, thereby dropping a bundle. Or maybe they were lucky enough to buy the lows - the October low was 850 on the S&P, and the November low was 750. Or maybe they are watching and hoping, like the rest of us.

Speaking only for myself, I intend to refrain from tearing out what is left of my hair over this miserable misallocation of assets until I see a few more facts, starting with determining whether the PGBC has actually implemented this dubious strategy. Of course, folks who are desperate for a Bush-bash will want to take a different course.

FEEL THE RAGE: Let's hear from some aghast lefties:

dday at the Washington Monthly and Hullabaloo does not think that Team Obama will stick with the strategy because "there's probably almost no money left in that portfolio". Oh, he (she?) will be so happy if /when this post catches his eye.

Bush Put All Your Pension Reserves Into Stocks Just As They Started Dropping

Was it Bush and not Cheney?

This wasn't stupid -- it was most likely a way to enrich certain
friends of The Party, buying from them just as the bottom fell out. We
need to look at the specific beneficiaries of this money to find out.

Third, the market was already beginning to tank when they made this decision. And Karl Rove knows you don't win elections if the economy isn't "strong."

Call me crazy. But it sure looks like some Bush flunkie put the
potential retirement of a bunch of Americans up in smoke so a guy who
married a $100 million sugar momma would have a shot at being
President.

Call you crazy? How about "lazy", as in too lazy to do a lick of research before joining the chorus.

As the Boston Globe reports
this morning in an important story, this past year--at the height of
the bubble market--the Bush administration implemented a "new
diversified investment policy" at the Pension Benefit Guarantee
Corporation, the entity established by Congress to guarantee pension
payments to workers when their companies go bankrupt.

"Implemented"? At the height of the bubble? Well, they implemented it without actually shifting assets, then.

The financial detectives need to look at what tranches Mr. Charles E.F.
Millard bought for the PBGC. Because this looks like he and Mr. Bush's
Cabinet Secretaries can be charged with fiduciary liability.

The decision to move a large share of the portfolio out of safe
assets like Treasury bonds and into riskier but possibly higher-paying
assets like stocks has been controversial.

The decision would have proved catastrophic had it been immediately
acted upon because the stock market has fallen so far. Fortunately,
P.B.G.C. has been slow to act on its new policy. By my
back-of-the-envelope calculation, had the agency fully adopted its new
investment policy at the start of last year, it would have lost around
12.2 percent of its assets by September 2008. Instead, it lost “only”
6.5 percent, or $4.2 billion.*

I re-endorse Prof. Krueger's concerns about the revised strategy:

It may make sense for universities and philanthropies to pursue an
aggressive, diversified portfolio strategy that is heavily weighted
toward equities and alternative investments. But it is not clear that
such a strategy is optimal for an insurer like P.B.G.C. because its
liabilities are also linked to market fluctuations. A philanthropy’s obligations are unrelated to stock market movements.
By contrast, when the stock market falls P.B.G.C. gets hit by a double
whammy: the value of its assets falls and its liabilities rise, because
private pension plans face greater shortfalls when the stock market
falls and the financial viability of companies themselves is
threatened.

BACKGROUND: The CBO and the GAO chimed in last spring and summer. As of July the PBGC was still finalizing its implementation plan.

[Rep. George Miller (D-Calif.)] blamed the $3.1 billion loss on the agency's investment in
mortgage-backed securities. Speicher confirmed that 6 percent of the
agency's portfolio is in mortgage-backed securities. But he said they
were fixed-income products and, therefore, not the cause of the drop.

Miller also questioned the agency's decision in February to adopt a
new policy that would allow it to invest 45 percent of its portfolio in
equities, 45 percent in fixed-income and 10 percent in alternative
investments. Previously, it could invest only 15 to 25 percent in
equities and 75 to 85 percent in fixed-income.

"The people served by the PBGC have already lost their original
pensions. . . . I don't think we should be investing in high-risk
instruments when this is the last chance for people to hold on to what
little retirement benefits they have left," Miller said.

The shift has not yet happened, however, with 70 percent of the
portfolio still in fixed-income. The new asset allocation, agency
officials said, would produce a more diversified portfolio and work
better for long-term investing.

If the Nutroots want to make themselves useful, I assume our Congressfolks can get unaudited results for Dec 31 2008 and maybe even a five-month result through February 2009. Then we might have actual facts to deal with.

Comments

Can I get a guide somewhere that will tell me which federal agencies' performances were Bush's fault and which ones were courageously independent? It's so hard to tell, sometimes. For example, when some guy at CIA spills the beans on the top secret wire transfer information we have on terrorists to the New York Slimes, am I supposed to blame Bush or the pinko who squealed? Or when the Coast Guard flies over 4,000 sorties in 10 days and saves hundreds of lives at great risk to their helicopter crews, is that Bush's fault or the Coast Guard defying orders?

It's so hard to keep up with these things! I'm sure in the Age of Zero things will be much clearer.

Question, when's the last time that Josh Marshall got the story right, crickets. . .
funny I recall, around this time, they were talking about how the pension fund, had gone down because it wasn't accruing enough
revenue, I read that somewhere

Sounds to me like the PGCB is perfectly positioned to take full advantage of the "buying opportunity" that O is so excited about. Maybe they can invest heavily in GM. How could the company not take off, now that the best and brightest minds in government are in charge?

Correct me if I am wrong, but I think Josh Marshall got a story right years ago. If I recall correctly, he found that opinion on the death penalty was not that different in the United States and most European countries. (I concluded that our system is more responsive to actual voters.)

But that was years ago.

(And I am sure that Marshall, after he thinks about it a bit, will agree with Boatbuilder. We are now in the best of hands.)

Honest to God, folks, I'm the depressive: why are you all despairing? The Obama folks do seem to be susceptible to political pressure, especially if it makes it appear Obama did something Wrong or that Looks Bad.

Maybe Newt Gingrich or John Cornyn, though I'm really not too sure about either one, especially now that Newt has drunk the Glowball Warming Cocktail (2 shots of Everclear, 1 shot of socialism, 1 shot of concentrated stupid, stir until your arm hurts, drink until data no longer make sense).

No, I think he's a true conservative. But this AGW nonsense seems to infect people one would have thought impervious to it, like Paul Volcker, Newt Gingrich and Richard Posner. Until they're cured of the disease, I'm not sure it's safe for them to be near keyboards and microphones.

I had forgotten about that story, Jim, that was also a very heretical piece that put him in the penalty box for a week or so. One recalls though from my narrow study of con law, that statistically legerdemain, which Dave Barry would say, is a great name for a band. like the Baldus study, which seeks to return the Death penalty to the Post Furman era, where Charles Manson escaped the noose. The kind of argument Elena Kagan, who has never argued a case
before the court.

Newt? I'm not so sure. Someone big was behind the "we gotta move to the muddle to get elected" nonsense, and I'm not convinced it wasn't Newt. The GloBull Warming nonsense is, well, just more of that same crap - move to the muddle, agree with some muddle crap to make us look "smart", or something.

Congress knew of the policy, and had been warned of the risks. See this letter from the Congressional Budget Office to to House Education and Labor Committee Chairman George Miller (a Democrat, incidentally).

Oh, and the GAO did a report last summer on the PBGC investment change. It's here. The GAO did not like the idea much, and thought the PBGC had inadequate controls to implement it successfully. But this issue, while obscure to credentialed bloggers, was known to the pension community and to the Congresscritters to whom the GAO reports.

The real outrage is that moving the fund more heavily into equities puts it right into the sector that the OBama administration has targeted for destruction. It seems that destroying the value of an economy can actually make it harder to pay future pension benefits. Who knew?

Thanks, Appalled for those links to the cbo and gsa docs. For anyone interested in getting ring-sized seats to the upcoming pension disasters nationwide, Pension Tsumnami is a good website: pensiontsunami.com/

Th PBGC website has all the annual reports back to the 1990s. Apparently Clinton was comfortable with equity investments too.

From the 1999 Annual Report page 17: "Cash and fixed income securities represented 60 percent of the total assets invested at the end of the year, as compared to 66 percent at the end of 1998, while the equity allocation stood at 39 percent of all investments compared to 33 percent one
year earlier." The equity increase was most likely from stock market gains (as the report indicates). But the level of equities is about the same as it was during the Bush years.

1) Sy Hersh of the NYTimes says Dick Cheney illegally used assasination squads of army men to kill his enemies, and that Cheney also told Israel that Obama was not ready for the big leagues. Jonathan Mann started the bogus reporting off, and was unable even to read his own teleprompter correctly, as his smarmy recitation of Cheney's supposed quotes did not match the actual words rolling in the background. Next came Wolf Blitzer, multiple times quoting Sy Hersh as the "Award Winning Journalist", as opposed to his multiple mentions of Cheney without positive adjectives. This was followed by

2) Wolf doing a story publicizing an Anti-Limbaugh Bus Tour. I'm not making this up.

Completely sick of that I tried MSNBC and was rewarded with

3) features on Michelle Obama's magnificent wardrobe and how everybody in England worships her. Strange how nobody in England worshipped Sarah Palin's wardrobe from the Campaign Trail.

Sometimes corporate social responsibility can mask or come at the expense of responsibility to shareholders. Fannie Mae, for instance, was named the No. 1 corporate citizen in America from 2000–04, based on datacompiled by the top U.S. social research firm, KLD Research and Analytics in Boston. Well, it does have a great diversity program.

As recently as mid-2008, three of the top eight holdings by the leading social investing organizations in the country were financial stocks: AIG, Bank of America, and Citigroup. AIG was praised for its retirement benefits and sexual diversity policies; Bank of America strove to reduce greenhouse gas emissions and promote diversity; and Citigroup donated money to schools and tied some of its loans to environmental guidelines.

Even before the sell-off, in the summer of 2008, while nearly 90 percent of nonunion funds met minimum safe funding thresholds—meaning they had adequate cash on hand to pay their benefits—40 percent of union funds were at risk.

LUN

Once one reads that article, I am convinced that you will sleep less well tonight.

The Next Catastrophe
Think Fannie Mae and Freddie Mac were a politicized financial disaster? Just wait until pension funds implode.

Nor does ignorance on the writer's part. Hedge funds come in all different sizes and colors, flavors too. One of the main attractions of many hedge funds in pension portfolios is low correlation to equities. Perhaps those hedge funds prevented steeper losses and possibly had significant gains during the market crash.

Domestic equities would be reduced under the plan, not increased. The reason PBGC in the past had much more in stock was simply that when penson funds fail and get taken over, their assets are transferred to PBGC, and in many cases that is stock. It is not that PBGC buys stock, it is trying to diversify away from domestic stocks that might impose systemic risk, many failing in a downturn like today. You see that the plan diversifies to foreign stocks, not increasing domestic stocks.

So then one might question instead whether it is wise to encourage or allow employers to fund pension funds with stock, or be required to fund with fixed income vehicles. Defined benefits would not be used unless they were more attractive than 401Ks, and unions and employers would like to make benefits competitive, so increased risk comes with increased employer payments to the fund.

It is hard to say that stocks are any worse under present conditions than bonds, considering the collapse of the CDS market. The proper assessment should not be the current state of the stock market and alternative 401Ks, but the discount rate necessary to invest over the long term to satisfy liabilities that will accrue over a long time as employees retire. This is a perennial problem, compare Obama's budget, and one that can be settled either through prudent accounting or politics. Insurance companies have invested in corporate bonds, but that involves risk of corporate default, when bondholders can be wiped out, at the same time as pension funds fail. If PBGC were to invest in Treasuries, currently it might have negative income from that.

There are a couple of problems that could be addressed by Obama's team. One is governance, the board of directors doesn't now provide much, and Congress has too much influence. Another is the problem of a private corporation sponsored by Congress. As with Fannie Mae, it has a moral conflict, moral hazard. It is charged to make money so the taxpayer doesn't have to bail it out, and also be free from risk to protect pensioners and employers. As with the GSEs, it turns out that in many situations it is really impossible to satisfy both demands simultaneously, there is no free lunch. In the end the fund must depend on the "full faith and credit" of taxpayers.

We don't know which scenario will prevail in the auto industry, but if there are failures then PBGC may have to double its deficit to $22 billion. In normal bankruptcies, employers can shed pension liabilities. But in big bankruptcies or in reorganizations not going through a judge, then unions can exercise power through Congress to manipulate the results.

There is the impending bankruptcy of many municipalities. Vallejo plans to shed pension liabilities under Chapter 9, and many other cities may find that employer payments will increase to unsustainable levels, this will create social unrest. It is good to discuss how things work and various policy alternatives now.

PBGC guarantees up to $54,000 a year (in a complicated formula, up from $30,000), but many auto workers and public employees want more. Will a bailout provide that? Or will PBGC have to ask for a bailout like Fannie Mae and Freddie Mac? If so, how much depends on your view of the economic future. It is simply wrong to blame this on a Bush administration move about stocks. Is it a matter for accountants and economists, or should it be settled with a class war between workers and capitalists?
What is the difference between looting by the bosses, by the workers, or by the taxpayers?